The company’s net profit unexpectedly dropped 4% YoY in 1HFY25 on significant increases in effective tax rate and minority interests and sharp fall in earnings of jointly controlled entities (JCEs) and its LPG sales business. We expect its earnings to surge 34% HoH in 2HFY25 as the earnings of its JCEs should normalise upon the booking of subsidies. We cut our 2024-26 earnings forecasts by 17-20% after post- results adjustments. Despite this, we reiterate our BUY call given its 7.8% dividend yield, with target price reduced to HK$7.58.
Key Factors for Rating
The company’s effective tax rate increased from 16.4% in 1HFY24 to 22.2% in 1HFY25 and its minority interests as a percentage of profit after tax also rose from 13.1% to 22.2% over the same period. In addition, its shares of earnings from JCEs swung from a profit of HK$231m to a loss of HK$310m mainly on the absence of government subsidy. All these, together with a 99% YoY fall in operating profit of its LPG sales business resulted in unexpected decline in earnings in 1HFY25. In fact, its EBIT actually surged 21% YoY.
The company was doing fine in its core natural gas sales operations with dollar margin improved from RMB0.57/m3 in 1HFY24 to RMB0.59/m3 in 1HFY25 mainly on lower upstream gas cost for C&I clients. While its retail gas sales volume only edged up 1.4% YoY, we think it is acceptable considering the lack of new projects and the shutdown of some of its clients in property related industries like ceramics and glass given the poor demand.
We expect its earnings to surge 34% HoH in 2HFY25 as the company has agreed on the subsidies with local governments in exchange for ensuring gas supply in some coal-to-gas conversion areas in northern China. More specifically, the upswing of the earnings of its JCEs alone will be HK$700m HoH based on the company’s guidance.
Key Risks for Rating
Further sharp rise in contract assets.
Further slowdown in gas sales.
Valuation
We reduce our DCF-based target price from HK$7.85 to HK$7.58 (or by 3%) despite the significant cut in our earnings forecasts. It is because part of our cuts come from higher minority interests which are non-cash. The reduction of WACC from 7.0% to 6.8% as a result of lower risk-free rate also helps. Our new target price is equal to 9.9x FY25 P/E.
New Residential Connections Dropped, but Commercial New Connections Surged
The company’s new connections of residential clients dropped 14% YoY to 904k HH in 1HFY25, achieving 70% of the mid-point of its full-year target of 1.2-1.4m HH. Nevertheless, its new connections of commercial clients surged 63% YoY to 24.9k on the conversion from bottle gas to piped gas. These new commercial clients will drive the growth of commercial gas sales going forward.
Engineering and Construction Segment Secured New Income Stream
Despite the decline in new residential connections, its engineering and construction segment surprisingly saw growth in both external sales and operating profit. The company has secured works from urban redevelopment in some cities in northern China. This new income stream could last for a few years. While it resulted in temporary increase in contract assets in 1HFY25, we believe the company should have no problem in collecting the money as the funding for such projects is directly from central government.
Weak Demand Compressed Wholesale Margin of LPG
The operating profit of its LPG sales segment plummeted 99% YoY to HK$2m. While the unit margin of its LPG retail business stayed flat, the margin of the wholesales business contracted about 44% YoY. The geopolitical tension in the Middle East kept import price of LPG high. However, the domestic wholesale price of LPG was weak as weak demand has prompted the propylene dehydrogenation (PDH) plants to buy less LPG as feedstock and hence left more LPG available as fuel.
While the company is taking measures to improve the profitability of its LPG wholesale business like setting up procurement platform in Singapore and deploying hedging when needed, it will take time for things to work out.
Value-added Services Kept Growing Fast
The operating profit of its value-added services grew 15% YoY on a 12% YoY growth in turnover in 1HFY25. The company is conducting its business on both traditional and online channels. It benefitted from the government’s subsidy for trading in old household appliances for new ones.
The company maintains its full-year guidance of 10%+ YoY growth in gross profit or operating profit for this business. This business has applied for a separate listing in the US. If successful, it will provide another platform for raising fund to further develop this business.
Changes in Earnings Forecasts
For the natural gas business, the company’s guidance for the dollar margin remains at RMB0.53/m3 for the full-year. However, it has lowered the growth target of retail gas sales from 5%+ YoY to 2%+ YoY for the full-year in view of the slow growth in 1HFY25.
In view of the situation in 1HFY25, we raise the effective profit tax rate from 14.1% to 19% and the share of minority interests to profit after tax from 14.5% to 20% for FY25-27. In addition, we also lower our growth assumptions for retail gas sales from 5.1%/4.6%/4.6% YoY to 2.8%/4.0%/4.0% YoY for FY25/26/27. Together with other minor changes, we cut our earnings forecasts by 17-20% for FY25-27.